Exchange Traded Funds: Calculate a Proper REIT Allocation

You don’t really need REIT ETFs for the income they provide. Some people have this notion that withdrawing dividends from savings is somehow okay but withdrawing principal is not. Don’t make that mistake. The reality is that if you withdraw $100 from your account, it doesn’t matter whether it came from cash dividends or the sale of stock.

If you need cash, you can always create your own artificial dividend by selling any security you like (preferably one that has appreciated).

Dividends shouldn’t be your primary reason for purchasing REITs. Your primary motivations for buying REITs should be diversification and potential growth. In the past, the diversification afforded by REITs has been significant, as has the growth.

The history of REIT ETFs

If you could go back in time 20 years, you might put, heck, everything in Apple. But REITs would not have been a bad option either. After all, they’ve done fabulously well, beating the S&P 500 and most other investments. Looking forward, of course, the picture’s a bit less clear. However, we can presume fairly safely that REITs will continue to move in somewhat different cycles than other stocks.

We can also presume fairly safely that REITs will continue to produce healthy gains, although people who poured money into them after REITs beat the broad stock market so soundly in 2010 will probably be disappointed. You will not see annual gains of 28+ percent a year for years to come. And you will see some bad years, such as 2008, when the collective REIT market fell by 39.2 percent.

Putting all the factors together, most investors should devote 15 to 20 percent of the equity side of their portfolios to REITs.

Split the baby: Domestic and international REIT ETFs

International REITs are worth breaking out of your international stock holdings for all the same reasons that U.S. REITs are worth having tucked into a larger portfolio of U.S. stocks. The REIT allotment you give to your portfolio might be evenly split between U.S. and international REITs, in keeping with the 50/50 split between U.S. and non-U.S. stocks.

About 65 percent of the world’s stocks are non-U.S.; it stands to reason that an optimally diversified portfolio will have good exposure to foreign stocks. You might have two REIT funds, and each might be given a 4 to 5 percent allocation in your portfolio.